What is the market thinking? The raucous cheers that greeted DoorDash's (DASH -0.52%) initial public offering on Wednesday -- sending shares 80% from an already elevated offering price -- are absurd.

Sure, the coronavirus pandemic has created a boom for third-party delivery services, but even CNBC's Jim Cramer thinks it's more a case of "rabid money" scooping up tech IPOs than any demand based on the fundamentals of the business.

Because the basis for the market's valuation of DoorDash is so messed up, I wouldn't come near its stock with the cliched 10-foot pole.

DoorDash driver on a scooter

Image source: DoorDash.

An expensive meal

DoorDash is the undisputed leader in food delivery. Data analytics firm Second Measure says DoorDash owned more than half the market in October, with a 51% share with Uber Technologies' (UBER -1.35%) UberEats a distant second at 23%, followed by Grubhub (GRUB) with 18%, and Postmates a distant fourth at 7%.

It's clear that with such dominance, DoorDash deserves a premium relative to its rivals, but not to the extent it's been given, and certainly not to the market as a whole.

 

Market Cap

Revenue

P/E Ratio

P/S Ratio

DoorDash

$54.3 billion

$2.2 billion

n/a

24.5

Grubhub

$6.8 billion

$1.7 billion

n/a

4.1

Uber

$90.8 billion

$13.0 billion

n/a

7.0

Data source: Finviz.com. Table by author. P/E = price-to-earnings. P/S = price-to-sales.

The industry is undergoing a wave of consolidation. Grubhub is preparing to be merged with Just Eat Takeaway.com (JTKWY -1.74%) for $7.3 billion, DoorDash bought Caviar last year for $410 million, and Uber is buying Postmates for $2.6 billion.

As the field of players narrows, the competition for share will intensify and pricing pressure will increase. And as the table above shows, that's not a good thing.

A black hole

Food delivery has not proved an easy space in which to make a profit. DoorDash has a history of generating losses, and because it says it intends to increase expenses in the future, both to expand its operations and capture more customers, profitability, when it comes, may be difficult to maintain. 

DoorDash hasn't reached that threshold yet, though it is getting close. It ended 2019 with $667 million in net losses, but at the end of September it had narrowed that to $147 million.

That's been Grubhub's experience, too. Where it had turned in profitable quarters previously, it is now reliably loss-generating, notching a $9 million net loss in the third quarter that brings its cumulative losses for the year to $88 million.

Uber is no better, though it's been shedding ancillary businesses in an attempt to turn profitable next year.

Intense scrutiny

However, the situation is not likely to improve in a post-pandemic market, as a COVID-19 vaccine will allow restaurants to reopen for dining, leading to a decline in demand for delivery. It's notable that even during the worst health crisis in living memory -- that has seen demand for food delivery services skyrocket -- these delivery companies are unable to turn a profit.

When the environment normalizes, the financial foundation barely holding up these companies will collapse.

Furthermore, they're living under an enhanced regulatory microscope these days due to sketchy business practices that have drawn the attention of regulators and politicians.

California recently enacted a law that prohibits food-delivery services from offering delivery from restaurants that they don't have a relationship with, and the Federal Trade Commission has been called on to open an investigation into some of their sales practices and fees charged.

It could get better...but it won't

Analysts at Morgan Stanley say food delivery has just 6% penetration (pre-pandemic), and forecast it could grow to as much as 18% by 2025, a tripling of the opportunity. 

Yet it comes with highly price-sensitive customers, 63% of whom only order if there is a promotion available. The growth prospects and the potential for limiting discounting as the industry consolidates could create a path to profitability, but it might harm the overall delivery market as consumers pull back.

There are just too many unknowns at this point, while the knowns don't look especially attractive or favorable. For DoorDash to have priced its IPO above the expected range and then have it take off from there as it did says the market isn't looking rationally at this company -- and it's why I won't be buying into this IPO stock anytime soon.